We Hate to Say We Told You So But Associations Need to Budget for Bad Debt

For the last two years, we have been recommending that California community associations add a bad debt allowance in their budgets. Since about 2000, rising home prices and the level of equity in those homes meant that few homeowners were willing to lose their homes through foreclosure for non-payment of their assessments. As a result, community associations were, for the most part, able to collect delinquent assessments and the fees and costs incurred in collecting same, and as a result, they did not see a disruption in the flow of income. Over the last year, we have seen a significant change in the economy. Many homeowners who could not really afford to buy their homes were able to purchase them with little or no money down and finance them with either subprime or Alt-A loans. They are now losing their condominiums, townhomes, and single family homes in planned developments in record numbers, as they cannot afford the increased costs of their loan and their association’s levied assessments. As a consequence, many community associations are not receiving the income that they expected when they distributed their budget for 2008. This shortfall has resulted in many associations not funding reserves. We are advised that some are not making all of the appropriate repairs and are deferring renovation and maintenance of the common area. This is NOT a good idea and could subject an association to liability if, for example, that failure to maintain or repair caused damage or injury.

The point is that if you have not yet distributed your 2009 budget, the board and management need to seriously consider adding what most businesses call a “bad debt allowance” in their budgets to compensate for the income that the association may likely not receive.

Having been in the community association business as attorneys for more than twenty (20) years, this is not the first time that we have seen an increase in homeowner defaults. We saw it in the eighties and again in the nineties, when homeowners were “upside down” on their mortgages. Now they call it “negative equity,” and already one million homes have been foreclosed on nationwide, with another one and a half million other homeowners potentially losing their homes in 2009.

Experts forecast a slow recovery through 2009. It is likely that many more owners who have negative equity will let their homes go to foreclosure. Associations need to collect as much income as necessary to carry out all of the association’s responsibilities; it is most likely the association’s only source of income. It is just not appropriate for associations to scrimp on important common area maintenance and repairs. While it might hurt financially, especially because there are so many homeowners that are seeing cutbacks or actual job losses, associations must be run like businesses and must have sufficient income to carry out the appropriate level of maintenance and repair. So, consider increasing assessments sufficient to meet an expected deficit in income from assessments.